The biggest electricity reform in twenty-five years

Britain’s electricity market faces three challenges. First, our demand for electricity could double by 2050 as we shift from fossil fuels to electricity for our vehicles and our residual home heating. Secondly, around a quarter of our generating capacity is ageing plant that will shut down within ten years, and has to be replaced. Thirdly, that replacement cycle - entailing some £110 billion of investment, or more than double the normal amount in the next decade - must be in low-carbon and secure sources like renewables, nuclear, clean coal and gas if we are to meet our climate change targets.

Left alone, the current market will not deliver these objectives at the lowest cost. All low carbon electricity generation needs support to capture its benefits to our climate and to ensure security of supply. As Lord Nicholas Stern has pointed out, climate change is “the greatest market failure the world has ever seen”. The true costs of unabated fossil fuels - and the benefits of low carbon electricity - have to be captured in policy.

There is also an inherent bias in investment towards gas because its up-front capital costs are low, and its variable gas costs move naturally in line with electricity prices. This provides companies with a more assured earnings stream than other sources. Yet private incentives do not capture public objectives. A new dash for gas would potentially leave us exposed to global fossil fuel price shocks and increasingly dependent on imports.

Gas will still play a significant role in our energy future, particularly if unconventional sources continue to grow in importance, and we successfully prove commercial-scale carbon capture and storage.

But nuclear and most renewables - particularly wind and tidal stream - are low-carbon sources of power that share the characteristic of high upfront costs and low running costs: the mix that investors most dislike when faced with uncertainty.

So today the Coalition begins a consultation on a reform that would reshape this market more fundamentally than at any time since the eighties, when the Lawson reforms were the pioneer of Europe’s deregulation. Since then, we have acquired an overlay of instruments - notably the renewables obligation - that has provided a piecemeal response to the need for more secure, low-carbon electricity.

By forging a comprehensive response, we can unlock investment in a broader range of low carbon electricity generation. By providing greater certainty, we can encourage new market entrants and financial investors, reduce the cost of capital, and provide low-carbon electricity at lower cost than under present policies. Our mix of four inter-locking policy instruments should provide greater assurance of decarbonisation at the same time as lower bills in the long run.

First, we propose a feed in tariff with long term contracts to give low-carbon investors a guaranteed price. Our proposals will ensure an active and liquid wholesale market and provide new investors with enough certainty to enter the market. The investor prepared to build plant at the lowest cost could win the contract, ensuring the consumer and the taxpayer pay the lowest possible price for low carbon electricity.

Guaranteed prices for all low carbon technologies are crucial, but there will need to be extra support for young technologies like offshore wind, wave and tidal stream whose development stands a good chance of further big cost reductions. We need a range of technologies for the same reasons that we invest our pension funds in a range of shares: the portfolio principle remains the best answer to uncertainty. However, there is no justification for paying extra support to nuclear, which is a mature technology. Hence our commitment that there should be no specific subsidy to nuclear.

The second mechanism is a capacity payment designed to ensure we have necessary back up plant. This is both to handle surges in demand - the Coronation Street ad break when the nation’s kettles go on - and intermittent supply - the cold, still days in February when the wind does not blow.

Those capacity payments would also pay to import electricity from European countries whose peaks differ from ours, thus saving on the need for new plant. Companies could also contract to provide reductions in demand at peak times (for example by temporary switching off of appliances like fridges and freezers or the suspension of industrial processes). Payments would also support storage schemes like Dinorwig, which uses off-peak energy to pump water uphill that can then be released during peaks to drive turbines.

The third mechanism - on which the Treasury is consulting today - is carbon price support. By taxing fossil fuels, this would send out clear market signals about the need for low carbon investment, and would also tilt incentives when using back-up plant towards clean gas rather than dirty coal.

The fourth mechanism - an emissions performance standard - is designed to fulfil the Coalition commitment that we will not countenance new unabated coal-fired electricity generation. It also sends out a powerful message, as it has done in California, about our long-term intent.

Taken together, these reforms can unlock private investment on an unprecedented scale, and ensure that we undergo the low-carbon electricity revolution at the lowest possible cost to consumers. It is time to get off the fossil fuel hook and onto clean, green electricity.